Banking vs. Accounting: `Stuff` every investor should know

[Sherilynn]

Greetings.



After hearing various questions about bank accounts and accounting at this weekend's Edmonton ACRE event, it was evident to me that many people may be confused about the relationship between Banking and Accounting. It seems that many people think they are one and the same, or that separate bank accounts for each property is a form of accounting. So if you are one of those people...don't worry, you are not alone.



The oversimplified answer is that banking and accounting are independent of each other and must be treated completely differently. For example, assuming that your real estate holdings are in your personal name, the CRA doesn't care in which bank account (personal or real estate) that you deposit the rent cheque, as long as you "account for" the rent as rental income. If you want to later use the funds to take a trip to Mexico, they won't care as long as you include the funds as income and pay the appropriate tax on it. So in this sense, banking and accounting are independent.



Here are some pointers that may help:

• 
  
  The most important element to both accounting and banking is to have an excellent bookkeeper who is experienced with real estate investing.
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    Get bookkeeper references and referrals from experienced investors and/or real estate accountants. Remember that "you don't know what you don't know," so don't simply ask the bookkeeper if he or she knows about real estate and blindly trust that the bookkeeper will meet your needs.
    • 
      
      
      
      You will also need an accountant that has a great deal of experience in accounting for real estate investors. Ditto for the references and referrals.
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        Never mix personal and investment/business borrowing. The interest on investment or business borrowing is tax deductible while personal interest is not. So if they mix in the same line of credit or credit card, you run the risk of losing the business tax deduction.
        
        
        Before I start discussing bank accounts, remember that security deposits (or damage deposits) must be kept in a separate savings account. My discussion below applies only to your day-to-day banking or chequing accounts.
        
      
      
      Never have a separate bank account for each property. While it may sound like a great idea to "simplify bookkeeping," it actually complicates matters, especially once you have a handful of properties.
      
      
    
    
    
    You can choose to use one bank account for all of your personally-held properties and one account for each of your corporations. Or you can choose to use one bank account for each JV partner. While both methods work, you need excellent bookkeeping regardless of which banking method you choose. Separate bank accounts is NOT a substitute for good accounting.
    
    
  
  
  
  You do not need a separate bank account for each JV partner, but you can. If you have a JV partner that wants access to the bank account, then you should have a separate account that includes only those funds connected to him. However, your JV partner doesn't need access to the account, so if he doesn't request access, then why complicate matters by setting up joint accounts?
  

Regardless of whether or not you are incorporated, have a "To/From Proprietor" account in your books. This account is for investing personal funds into your business and withdrawing profits from your business for personal use. So when you want to use rental income to fund that trip to Mexico, the withdrawal from the business bank account is entered in the books as money going to "To/From Proprietor." This way, every penny can be accounted for and your bookkeeper will be able to properly reconcile your books to your bank statements.

• 
  
  
  
  While banking and accounting are independent, your accountant and the
  CRA should be able to not only track every penny to and from every
  property, but also to and from every bank account.
  • 
    
    
    
    Have a separate "class" for each property. (Class is a QuickBooks term - I'm not sure what the Simply Accounting equivalent is.) This will enable you to track every penny in an out of each property, making reporting to JV partners and the CRA much easier.
    
    
    Here is another reason to have one bank account: pooled funds. Let's say that Property
    X has used up its repair budget this year on new shingles, but then the some unexpected repairs are required and Property X needs another $2000. Since I use one bank account for all of my properties, I have plenty of pooled money in that bank account in order to fund the repair. And since I have a "class" in QuickBooks that tracks the $2000 expenditure and connects it to Property X, it makes no difference whether the money came from a pooled bank account or an account connected to only that property. And on the next Profit & Loss statement (aka P&L; aka income statement), the extra $2000 will be shown against Property X and reported to the JV partner and the CRA (neither of whom care from which bank account the $2000 originated).
    
  
  
  If I had been using a separate bank account for each partner, I would not have had those pooled funds, and I may have required a $2000 cash call to the JV partner. Instead, we simply show less profit this year for that property and the cashflow payout is adjusted accordingly.
  

The bottom line is this: you have a business (incorporated or not) and every penny in and out of your investment business and in and out of each property must be properly accounted for; banking are and accounting are not the same thing, and good banking can never replace proper accounting.



(Please note that I am neither a bookkeeper nor an accountant, and I encourage everyone to seek qualified, professional advice on all matters related to their businesses.)

 

[Thomas Beyer]

Good insight in here !



The monthly bank account is often referred to as the spine of accounting, as it forms the base of accounting. Often it is enough to give the quarterly bank statement with associated expenses/revenue receipts to an accountant to create quarterly statements [ we now do it monthly due to higher volume / larger figures but I used to do it quarterly on my first few buildings]



If you use an LOC it is indeed critical to separate personal from business expenses, and many banks therefore allow one LOC to be separated into several sub-accounts for this very purpose.

 

[Sherilynn]

Thanks, Thomas.



I agree that the bank statement can be the spine of accounting, and definitely helps to track funds.



Everyone must also understand that they need to categorize each transaction. For example, a purchase from Rona could include a capital cost (like an upgraded window), a repair expense, an appliance, janitorial supplies, administrative expenses (like a new tenant gift), and even office supplies.



To further complicate matters, receipts for many stores do not make it clear what an item is. I have a Costco receipt in front of me that says "DURABEAM LGT." Does anyone have any guesses as to what that is and how it should be categorized? (I remember now as I just bought it last month, but in another two months I may not have a clue what that is or for which property it was purchased.)



We cannot simply pass a bank statement and a box of receipts to our bookkeepers every three months and expect accurate books. So another pointer is to write a note on each receipt to say what the item is (or its purpose) and for which property it was purchased (which, I'm certain, is what Thomas' staff would do).



For the above example, I would write: "Millwoods 5421: light."